Regulatory daisy chain threatens advisors

Her boss, president and CEO John Illidge, admitted to manipulating Hucamp’s share prices between late 2000 and 2001. Regulators halted trading in May 2002, and Illidge told the OSC he lost more than $4 million as a result.

Read: Enforcement stacked against accused, expert says (from 2005)

OSC initiated proceedings against McLean, Illidge and other executives in July 2005. In September 2008, the regulator reached a settlement agreement with McLean. It states she “was aware of some trading in which other respondents were engaged which could be characterized as abusive.”

She agreed to a five-year trading ban (aside from two personal accounts), a $10,000 fine and a 10-year ban from being a director or officer for a reporting issuer. Within the agreement, she denied the settlement was an admission of misconduct. Some have called her a whistleblower because she voluntarily met with OSC staff to bring up her concerns about Hucamp.

(OSC permanently banned Illidge, but vice-chair James Turner told The Toronto Star the commission didn’t fine Illidge because he was bankrupt.)

McLean’s troubles continue

Here, things get complicated.

McLean was also registered in Manitoba and B.C. And those securities commissions could, and did, go after her, because of what are known as reciprocal agreements. These provisions allow for enforcement of one jurisdiction’s sanctions in another in the absence of a national securities regulator.

So, in June 2009, the Manitoba Securities Commission issued a notice of hearing, saying it “sought to reciprocate portions of an OSC order issued” against McLean.

She appealed, saying the six-year statute of limitations on her 2001 conduct had expired. MSC sidestepped the problem, instead ruling it couldn’t determine from OSC’s settlement that she breached the Ontario Act, and therefore did not uphold the reciprocal order.

Read: Five reasons for a national regulator

Then, in May 2010, B.C. issued yet another reciprocal order. Again, McLean argued the statute of limitations had expired. BCSC, however, said the limitation clock reset in 2008 when McLean settled with OSC, which put its enforcement action within the six-year window.

She appealed, but in 2011, the British Columbia Court of Appeal upheld BCSC’s interpretation of the limitation period. So McLean appealed to the Supreme Court of Canada (SCC), and the hearing was held March 21.

Her concern: if the six-year clock reset every time she reached a settlement, she could be under threat of litigation the rest of her life if all 13 regulators chose to prosecute, presuming she were registered coast-to-coast.

While McLean wasn’t a client-facing advisor, her case is relevant because she violated securities law, and her troubles could happen to any advisor registered in multiple jurisdictions.

The industry intervenes

With that in mind, industry association Advocis applied for intervener status, which lets it present evidence in support of either party — in this case, McLean.

Read: Advocis to fight legal precedent

It did so on the advice of its regulatory team and board, says Ed Skwarek, vice-president of regulatory affairs. The SCC approved the application March 11.

“If there is a claim against a financial advisor, it should be dealt with in a reasonable period of time,” says Greg Pollock, president and CEO of Advocis, who says the organization has been working on this case for 18 months. Under the current system, “The McLean decision could take decades to be dealt with.”

Lou Brzezinski, a Blaney McMurty lawyer who represented Advocis at the SCC hearing, adds the association’s goal is to avoid an unwanted legal precedent.

The OSC also has intervener status, but said it could not comment for this story because the matter is before the SCC.

What’s the risk?

Increasingly, advisors drum up business across Canada, which means they have to be registered in multiple jurisdictions — opening themselves to multiple scrutinizers.

“A single piece of improper advice given to a group of clients could be seen as violating the Securities Act in more than one province,” says Gordon Johnson, a partner in the Vancouver office of BLG. If those clients lived in every Canadian jurisdiction, “there can be multiple enforcement proceedings in as many as 10 provinces and three territories.”

He says it’s “healthy” that SCC granted Advocis intervener status. “The risk of unfairness of these cross-jurisdiction problems hasn’t gotten enough attention,” he says. “Commissions must take seriously their obligations to consider what’s happened elsewhere.” And that usually happens, says Brzezinski. He adds an affidavit McLean filed in March stated 93% of the 147 cases the Canadian Securities Administrators heard in 2011 went to sentence within six years. (The SCC disallowed the evidence because it was submitted too late.)

“If there’s an order made, the reciprocating provinces can commence their prosecutions within six years from the date of the underlying misconduct,” Brzezinski says. So McLean and Advocis argue that other regulators have enough time to impose sanctions, and rarely need the broader interpretation of the limitation period BCSC is arguing for.

John Fabello, a partner with Torys LLP in Toronto, successfully argued a limitations period case in 2005 against the OSC. He says the statute of limitations on common-law claims is just two years.

As such, he calls the BCSC decision unfair. “Instead of looking at the alleged [misconduct] facts that staff would need to prove at a hearing, they’re hinging the limitation period off a public settlement agreement that would not have to be proven,” he says. “That is not within the spirit of securities act limitation periods, which is to provide certainty to respondents.”

Fabello adds, “In Canada, we still have to publicly admit wrongdoing. Not only does that mean a respondent is exposed civilly, but also another commission could extend his liability. It creates two prongs of potential liability.”

But how likely is a regulatory daisy chain?

Michael Feder, a partner with McCarthy Tétrault in Vancouver, says, “You may have doubling or tripling, but not an infinite chain of limitation periods being strung end-on-end. That’s a bit fanciful.”

Tracey Cohen, a partner in the Vancouver office of Fasken Martineau, agrees the serial extension isn’t a compelling argument. “The further out in time you are from the initial settlement agreement, the more difficult it would be to legitimately conclude it was in the public interest to make the order,” she says.

The deal with reciprocal orders

Enforcement is expensive. And every regulator will say it’s under-resourced. So it’s standard practice that one regulator take the lead in prosecution.

But secondary regulators can’t simply piggyback on the lead regulator’s actions. In fact, the B.C. Court of Appeal upheld part of McLean’s appeal on the grounds BCSC relied entirely on the OSC’s ruling in imposing its sanctions.

BCSC’s ruling, dated May 14, 2010, is a scant 200 words (McLean’s settlement agreement with OSC runs 20 pages) and only cites the OSC’s decision as evidence. It lays out the same sanctions, save the $10,000 fine.

A regulator can’t do that; it has to give reasons, says Cohen. “It actually has to consider, based on evidence, whether [reciprocal sanctions] are in the public interest,” she says. “[BCSC] has to consider whether or not there’s a basis for an order in its jurisdiction.”

Commissions aren’t obligated to issue such orders. “If the issue’s been adequately dealt with somewhere else, they don’t have to,” says Johnson. “If there was separate conduct within each jurisdiction, they would be likelier to go after it.”

But even if that’s not the case, one Toronto securities lawyer suggests commissions use reciprocal orders to bulk up their enforcement statistics. Issuing these orders raises settlement rates with minimal incremental cost.

That’s not necessarily bad.

Cohen says as long as orders are truly reciprocal — “the sanctions are the same, not more onerous” and cover the same time periods — then it’s reasonable to avoid duplicating effort. “Without a national regulator, you want to encourage the practice of a lead jurisdiction,” she adds.

But Brzezinski says at the SCC hearing on March 21, “The OSC intervener admitted that nothing in the legislation stops the reciprocating province from making the order longer.”

While that doesn’t usually happen, it means “there isn’t a real reciprocal enforcement statute,” he says. “So the necessary check and balance is a limitation period.” He adds if McLean had committed her alleged misconduct in B.C., her limitation clock would have started the date of that misconduct, not from the date of Ontario’s settlement agreement.

“Why does it make a difference that the act was in Ontario?” Brzezinski asks. “Why are you treating people differently from inside and outside the province?”

What the case could mean

If the SCC overturns the B.C. Court of Appeal’s ruling, regulators could take it as a signal that they have to initiate parallel enforcement action, known as piling on, say legal experts.

The ruling “will tend to encourage a multiplicity of proceedings by different regulators because there’s no way for them to stop the running of the limitation clock,” says Feder.

“If I were a securities regulator, I could no longer wait to see what happens in other provinces. I’d have to initiate a proceeding.”

Cohen says that doesn’t serve the public interest because of the added cost.

Piling on often occurs when there’s a substantial connection between the misconduct and the jurisdiction; “very often there isn’t,” says a former securities lawyer, and yet it still occurs.

This lawyer’s tried to get regulators to cooperate when multiple jurisdictions were investigating a dealer for the same conduct, “but they all wanted a piece of the sanction pie. It was difficult to deal with their competing aspirations for glory and money.”

Advocis president and CEO Pollock says the organization’s intervening in this case to help both clients and advisors reach faster resolutions.

“If the regulators are forced to share more information, things will be dealt with more expeditiously,” Pollock says. “We want reciprocity between the commissions in order to get the bad actors out of the industry.”

And what about bad actors who run loose as a result of slower regulatory movement?

“That’s the dilemma the SCC will deal with,” says Brzezinski. “Do we pile on advisors because of an imagined ill that will befall the public? Do we treat everyone properly under the rule of law and give people some repose from the actions they’ve committed?

“What’s the balance between protecting the individual and the public? That’s the way our process works. It’s a system of checks and balances.”

How to protect yourself

Good news: if you stay close to home, you’re probably safe.

“An advisor who carefully limits his or her activities to one province has a very low risk of facing a problem in another jurisdiction,” says Johnson.

But that’s not always an option. If you find you’ve got multiple regulators breathing down your neck, be proactive.

Another legal expert says, “If I were in McLean’s situation, when it came down to the settlement agreement and the sanction had already been negotiated, I would say, ‘I want to make sure I won’t be subject to piling on. I want OSC to canvass the other commissions and get sign off. Otherwise I’m not entering into the settlement agreement.’ ”

Regulators like settlements, he notes, because hearings are time-consuming and expensive.

Cohen offers further advice. “Avoid making admissions [of guilt],” she says. “Regulators often insist on putting in recitals that the parties agree it’s in the public interest for the order to be made.

“Avoid agreeing to that, because if you agree in one jurisdiction, it would be pretty hard to oppose that in another jurisdiction.” But it would be difficult to reach a settlement that way, she concedes.

Another option: If the agreed-to facts are limited and specific to the jurisdiction, that will help avoid a reciprocal order in another, she says. So if you’re negotiating an agreement in Alberta, make sure you append “in Alberta” to as many parts of the settlement agreement as possible.

What this could mean for a national regulator

A majority of these issues could be solved with a national securities regulator, experts agree, since all provincial bodies would be bound by one jurisdiction’s decision. Sentencing would also be national.

And the 2013 Budget implies this may become a real possibility.

A Toronto securities lawyer says reciprocal orders were added to securities acts as stopgaps since we don’t have a national regulator, and a positive ruling for McLean may reveal their deficiencies.

Lou Brzezinski, counsel for Advocis, says in an ideal world, McLean’s success “would lead to a national regulator.”

Greg Pollock, CEO of Advocis, agrees. “There has to be one-stop access into the system, not multiple access points where people will face double and triple jeopardy.”

But Tracey Cohen, a Vancouver securities lawyer with Fasken Martineau, suggests McLean’s success could cause regulators to each exercise more autonomy.

“They would be concerned about not stepping in early and being precluded from making an order in their jurisdictions,” she says.

American precedent

Counsel for Advocis used the example of a recent American case, SEC v Gabelli, in its SCC arguments. In this case, Marc J. Gabelli had allegedly defrauded investors in 2002. The SEC began enforcement proceedings in 2008, more than five years afterward. Gabelli argued that was invalid, since the statute of limitations (five years) had already expired.

SEC argued the clock shouldn’t have started running until it discovered the alleged misconduct. The Supreme Court of the United States overturned that interpretation, saying the SEC’s job is to discover fraud, and that it has the necessary resources at its disposal. It ruled in favour of Gabelli, and the case was dismissed.